Reliance Rail: Double-decker deal

The Reliance Rail financing was the largest availability payment-based PPP ever in Australia, and one of the most complex rail financings ever. It used a mixture of synthetic CPI bonds, nominal bonds, junior bonds and wrapped bank debt, elements of which have cropped up in subsequent financings in Australia and elsewhere. It would, like other early-2007 deals, be difficult to repeat on these terms, but still stands as an impressive achievement, and one for other governments to examine of they are looking to procure rail assets on this scale.

The sponsors of the A$2.4 billion ($2.2 billion) project are Downer EDI, Babcock & Brown and ABN Amro, The three formed a consortium to pursue a bid for the New South Wales rolling stock contract. The three were selected in November 2006, beating out competition from a United Group and Mitsubishi with Macquarie grouping.

The procurement process, started in 2004, was originally split into two sections – for single-decker and double decker trains – but after attracting four bids for the single-deck contract and two for the double-deck decided to pursue a single large order for double-deck train only. The two consortiums submitted bids in May 2006, and Reliance won in November 2006.

Covered by the contract are 624 new rail cars, equivalent to 78 eight-car train sets, and of which the project company must make 72 available each day. The trains replace 40% of the Sydney City Rail Network's cars, which were nearing the end of their lives. Constructing the trains is a joint venture of Downer EDI and Hitachi, using subcomponents from Changhun Railway Vehicle in China. EDI Rail is also the lead contractor for a maintenance facility, on its own one of the largest buildings to be constructed in the state as a PPP project, but is subcontracting the work to John Holland.

The contract is a complex blending of political, operational and financial priorities. Railcorp, the state-owned rail operator and the consortium's counterparty, will operate the trains, and its unionised workforce will drive them. But the consortium will be responsible for building and maintaining the trains, and for them being available to run at the start of each day. Political considerations also mandate that the trains are assembled at a site in New South Wales.

The project does not feature any patronage risk, and so the sponsors were able to employ high levels of leverage. The three brought in AMP Capital Investors as a 25% cornerstone equity investor, while Downer has a 49% stake and Babcock & Brown Public Partnerships and ABN Amro Australia each own 12.75% stakes. Since ABN Amro and B&B both have financial adviser roles and are compensated as such, and Downer is the main contractor on the project, AMP, which is only compensated with dividend income, is the conscience of the equity group.

For all its maturity, the Australian debt markets for PPP projects are still relatively shallow. The challenge for arrangers was obtaining enough debt, at an attractive enough price, to finance the order. Wrapped bank debt had a limited history in Australia, and several bankers were sceptical that there would be sufficient take-up. But wrapped bank debt was but a single element of a much larger mix of debt.

The financing broke down into A$1.8 billion in senior bond debt, A$100 million in junior bond debt, A$357 in wrapped bank debt and A$143 million in equity. The senior bonds consist of A$300 million in 30-year indexed annuity bonds, A$400 million in 10-year nominal bonds, priced at 24bp, A$400 million in 11-year nominal bonds, at 25bp, A$380 million in 12-year nominal bonds priced at 26bp, A$320 million in 14-year nominal bonds priced at 28bp. The 15-year junior bonds priced at 32bp.

XL Capital Assurance and FGIC wrapped all of the debt to what was then AAA/Aaa, though both have since been downgraded. The wrap, however, locked in the above low pricing levels, and allowed the project to minimize its exposure to volatility in base rates. Some of the debt, however, will need to be refinanced over the terms of the 30-year CPI swaps, which were provided by Citigroup and ABN Amro. ABN Amro underwrote all of the bonds on 8 September 2006, and sold these on in late February 2007.

The deal was closed in a very short period between selection and ABN Amro's underwriting commitment. The speed is testament not only to the strength of the underlying procurement and maintenance subcontracts between the project company and its subcontractors, but also the strength of the specifications of the NSW PPP contract.

The only rail procurement that served as any kind of precedent, was the London Underground PPP, one that few close to the deal would care to cite. Of the two winners of the Tube PPP, one – Metronet – used the shield of a generous government comfort letter to countenance a hazy relationship between equity providers and subcontractors. Reliance, though a much more specific set of contracts, a more limited remit, and a more disciplined sponsor group, has produced a more workable template.

It is tempting to speculate on what route the financing might have taken in the current credit environment. Since Reliance closed, Babcock & Brown enjoyed a reasonable degree of success with the CPI debt component of the Victoria Royal Children's hospital financing, but has found selling the combined wrapped senior and uncovered subordinated bank financing for the US Trans-Bay cable more of a slog. But Reliance shows the way in rail asset procurement.

Reliance Rail
Status: Underwritten 8 December 2006, syndicated March 2007
Size: A$3.6 billion
Location: Sydney, New South Wales, Australia
Description: DBFM contract for 78 trainsets for Sydney's commuter rail network
Sponsors: Downer EDI (49%), ABN Amro Australia and Babcock & Brown Public Partnerships (each with 12.75%), and AMP Capital Investors (25.5%)
Debt: A$2.257 billion
Bond underwriter: ABN Amro
Bank arrangers: Westpac, National Australia Bank, Mizuho, Sumitomo Mitsui
Swap providers: ABN Amro, Citigroup
Monoline insurers: FGIC, XL
Financial advisers to the sponsors: ABN Amro, Babcock & Brown
Financial adviser to government: PwC
Legal adviser to government: Clayton Utz
Legal adviser to Reliance Rail: Blake Dawson Waldron
Legal adviser to lenders: Mallesons Stephen Jaques
Independent engineers: GHD, Interfleet